Stock Price = Value.
This can be the biggest blunder an investor can commit while investing in the stock market.
Consider this –
HDFC Life Insurance stock price – Rs. 605
Axis Bank stock price – Rs. 434
You should Invest in Axis Bank or HDFC Life Insurance? No, right?
Does this stock price tell you anything?
However, in reality, stock price doesn’t tell you a bit about which stock is better or cheaper. Stock price is just the price you pay to buy and sell securities in the stock market. It only depicts the company’s market value which is the price agreed upon by a buyer and seller. Or in short, the demand and supply in the stock market, which doesn’t tell a thing about whether it is expensive or cheap.
So, How to Understand if a Stock is Cheaper or Not?
There are many ways to do it. One is, you understand and analyze the various qualitative and quantitative aspects of the company such as cash flow flows, P&L statement, Balance Sheet, pedigree of the management, risk management policies, corporate governance policies, etc.
Based on this analysis, you gauge a company’s intrinsic value, and then compare with the stock’s price.
If the stock price is higher than the intrinsic value, it is expensive. And if the stock price is lower than the intrinsic value, it is cheaper.
In short, stock price doesn’t tell you a bit about the value of a company and how cheap or expensive.
Investors often make this crucial mistake of looking only at the stock price, because that is the number which appears everywhere be it stock tickers, news channels or business newspapers.
The guru of value investing, Benjamin Graham, simplified this concept by saying that in the short run, the market is like a voting machine – tallying up which firms are popular and unpopular. But in the long term, the market is like a weighing machine – assessing the substance of a company.
Investing with an Owner’s Mindset
When you invest in a particular company, you become a part-owner of the business.
As Warren Buffet rightly quotes, ‘If you are not willing to own a stock for 10 years, do not even think about owning it for 10 minutes.’
Hence, when you invest for the long term, the fluctuations in the stock price in the short term should not bother you, as long as the fundamentals are intact.
Obviously, there would be ups and downs, but if the fundamentals are intact, they would be the first one to recover and rebound. It is always recommended to invest after conducting a rigorous fundamental analysis of a company.
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Look at Market Cap and not Stock Price
Consider this –
HDFC Life market cap – Rs. 1.2 tn
Axis Bank market cap – Rs. 1.2 tn
Does this market cap (market price * number of shares outstanding) tell you which company to buy?
Again, it doesn’t tell you much about the value of a company, but it tells an important thing. It tells how much the company is worth in the stock market. Obviously, there are other factors to consider, such as debt and cash and cash equivalents to arrive at the enterprise value. However, market cap is a good starting point to gauge what it costs to buy the entire equity of a particular company.
Coming back to the point, say if you had Rs. 1.2 tn and could buy one company out of the above two, which one would you buy? Obviously, the first step would be getting back to the basics such as ROI, cash flows, debt, capex, return on capital employed, growth prospects, competitive advantage, etc.
Obviously, the sooner you can start getting returns on your investments, the more that company would be preferred.
Well, it doesn’t tell much about the value. But looking at market cap rather than stock price is a good way to develop owner’s mindset.
To conclude, one should always invest with an owner’s mindset, be it bull or bear run.
If the stock is going up, many investors jump in the bandwagon, with an expectation of encasing on rising stock prices. Similarly, during the time of market correction, many investors jump in the bandwagon, expecting returns as the stock price recovers.
For a few investors, these bets payoff, while most of the times they don’t. The difference, as I said before, is the VALUE.
When you invest in quality stocks with an owner’s mindset, you don’t have to do much apart from waiting and allowing time to grow your wealth.
So, invest in quality stocks and wait…